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Draft Policy Paper on

Foreign Aid

Latest Draft

Nepal Development Forum-2002

His Majesty's Government of Nepal Kathmandu

February, 2002

TABLE OF CONTENTS

I. OVERVIEW: ROLE OF FOREIGN AID

1

II. AID PERFORMANCE

2

III. CHANGING CONTEXT OF FOREIGN AID POLICY

5

IV. Guiding principles and objectives

7

V. Aid Priorities for the short term

9

VI. Aid priorities for the longer term

10

VII. Major policies

11

VIII. Major strategies

16

IX. Major policy instruments Institutional frameworks

and

18

X. Government/Donor interaction and dialogue

20

XI. Conclusion

21

I. FOREIGN AID POLICY

I. OVERVIEW: ROLE OF FOREIGN AID

1.1 Foreign aid as an instrument of financing development activity dates back to mid-fifties

when Nepal embarked on the process of planned development with the launching of the First Five Year Development Plan,1956-61. Since then, a substantial portion of development expenditure averaging about 55 percent per annum has been financed through foreign aid. Currently, foreign assistance remains around 5-6 percent of GDP p.a, and finances about 25-30% of total government expenditures. In terms of sectoral distribution, agriculture, forestry and fisheries have received the largest share of foreign aid, followed by energy, transport, health, social development, and human resource development.

1.2 Foreign aid continues to play an important role in Nepal’s development. Apart from its

contribution to sustaining public investment, foreign aid is crucial to meeting the objective of poverty reduction, as articulated in the recent government Five Year Plans, by achieving high and sustainable rates of economic growth and by underpinning critical sectoral programs and activities. In the context of the Nepalese economy, which is characterized by structural bottlenecks, large fiscal and external deficits and significant imbalances between savings and investment ratios, the role of foreign aid is particularly significant. It helps to: (i) supplement and enhance Nepal’s meager domestic savings so as to mobilize increasing resources for poverty alleviation, (ii) channel increased resources towards priority sectors of the economy to accelerate

development activity, (iii) create an environment for attracting foreign direct investment and private sector investment, and (iv) improve the nation's capacity to identify, evaluate and adapt technology to accelerate production and productivity of the economy, which is one of the basic conditions for achieving the poverty alleviation objective.

1.3 Nepal’s foreign aid structure has undergone significant changes in recent years. The

share of bilateral assistance in total aid has declined to around one-fourth currently. Similarly, the

share of grant assistance in total aid continues to dwindle, while that of loans has recorded a significant increase to around three-fourth of the total aid. Another striking feature of the current pattern of foreign aid is the increasing share of technical assistance in total foreign aid. Over 40% of all aid now is technical assistance; and free standing technical assistance, which accounts for the bulk of technical assistance has increased in the 1990-1999 period at an annual average rate of 17%. And, with the steady rise in the ratio of loans within total aid, total outstanding external debt remains around 55 percent of GDP, which is not particularly high by the standards of developing countries, but nevertheless a growing burden for Nepal.

1.4 Recognizing the critical role that foreign assistance plays in the economy, this policy

paper seeks to both mobilize increased assistance to help finance development activities, and to maximize its impact and effectiveness in terms of achieving better development results. The paper begins with a brief review of past performance of and problems associated with aid, from both donor and national perspectives. It then outlines the steps the government is taking to address these concerns, including the formulation of new guidelines, strategies and policies which are aimed at influencing/regulating the flow and composition of aid and for ensuring better utilization of such assistance. It also includes with a brief discussion of the implications of the

new policy for donor assistance, and what adjustments donors themselves will need to make in their assistance programs and policies in order to support Nepal’s development effort. 1

II. AID PERFORMANCE: KEY ISSUES

2.1 Nepal is considered a late starter in development in the South Asia region. The country

was opened to the outside world only in the early fifties; and planned development efforts and aid inflows began almost simultaneously. Over time, foreign aid has historically proved to be an effective instrument contributing to significant improvements in the socio-economic development of the country; and much of the physical infrastructure such as roads, irrigation facilities, hydropower, as well as education and health services, drinking water and sanitation facilities have been built with foreign assistance. It has also contributed to the development of policy dialogue, catalyzed economic reforms, enhanced the capability of public policy makers; and provided financial assistance for public services. A longitudinal relationship can be observed among foreign aid, economic reform and development in Nepal. Notwithstanding these achievements, foreign aid in Nepal has had its shortcomings as well. Progress in economic growth and poverty reduction has not been commensurate with the inflow of aid into the country. Foreign aid has thus become very effective in some areas but less effective in others. This perception of mixed results is strongly shared by the donor community as well as Nepalese recipients.

2.2 Of course, problems associated with foreign aid are not unique to Nepal. Elsewhere, both

recipient and donor countries have expressed major concerns regarding the policies, practices and procedures that govern foreign aid. Although there are common issues, which concern most recipient countries, there are also problems unique to individual countries. In Nepal’s case, there are many country-specific constraints, such as shortcomings in institutional capacities, its geographical location and mountainous terrain, widespread poverty, its high growth rate of

population and urgent environmental concerns, among others, which pose daunting challenges to development and the effective absorption of aid. When examining the problems relating to foreign aid, it is essential that these special challenges confronting Nepal be borne in mind. Sometimes this is not the case, suggesting that there is probably a lack of mutual understanding among some of Nepal’s development partners with regard to these problems.

2.3 Despite an increasing flow of external resources for Nepal’s development, the country has

not been able to optimize the gains from aid. Discrepancy between the results achieved from aid resources and their potential for enhancement is still wide. There are many reasons for this. The growth impulses generated from past investments have remained weak, fundamentals of overall economic stability continue to remain shaky, absorptive capacity has not significantly increased and institutional capacity in many areas is inadequate to respond to development needs. It is rather disappointing that such a situation continues to persist, despite efforts spanning almost five decades and the increasing inflow of financial and technical assistance into the country. The key problems contributing to ineffective foreign aid management and poor development results from

both the donor and country perspectives are briefly outlined below.

1 In addition to the latest draft Foreign Aid Policy Paper, several papers which have important linkages with external assistance will be presented to the NDF meeting : (i) A revised I-PRSP, which is also the Approach Paper for the Tenth Plan; (ii) A summary of the Tenth Plan, (which is the full PRSP); (iii) Several Papers on the Medium Term Expenditure Framework (MTEF) which is currently under preparation; and (iv) A Review of Development Partnership in Nepal: Expert Panel’s Main Findings and Recommendations.”. The Foreign Aid Policy Paper briefly draws on the discussion in these papers, where relevant.

Donor Perspectives

2.4 Over the past few years, (leading up to the last Nepal Development Forum meeting held

in Paris in April 2000, and thereafter), there has been considerable discussion about the mixed record of aid effectiveness in Nepal, the factors contributing to this phenomenon and possible solutions to the problem. Among the major concerns identified by the donor community have been the following: The lack of ownership by the Government of development projects and programs, particularly those financed by donors; lack of leadership and direction by HMG, particularly in expenditure prioritization, and taking more responsibility in designing, preparing and implementing projects and programs; a poor, often unrealistic, and top down planning and budgeting process with little involvement of other stakeholders, including local level institutions, community groups and beneficiaries in program preparation and implementation; pressure to increase development projects and programs beyond the levels that can be effectively handled within the country’s limited institutional and absorptive capacity; poorly functioning institutions, particularly a dysfunctional and under-paid civil service, with little incentives and motivation to

improve its performance; poor program supervision and monitoring, in turn leading to lack of accountability and transparency, leakages and misuse of resources; and so on. To circumvent these problems, while urging the government to take more ownership and leadership, some donors have reduced their aid levels and formulated strong conditions in their aid programs; others have reduced their efforts to work through the central government and tried to work more directly with local bodies, NGOs and community groups; or engage their own implementing agencies and consultancy companies.

National Perspectives

2.5 These donor perceptions are largely shared by the Nepalese recipients, who also see

donor behavior and practices as important factors contributing to the problem of lack of aid

effectiveness.

2.6 As seen by the Nepalese there is a mismatch between development priorities as

determined by Nepal, and the priorities of donor countries and institutions. Considerable efforts have been made to reconcile Nepal’s priorities and those of its donors. Despite these efforts, there is the perception that many projects and programs are still excessively driven by donor demands. As a consequence, the effectiveness of foreign aid is reduced. The solution to this mismatch, as widely recognized now, lies in the government taking the lead, in consultation with local stakeholders, in setting national priorities (on the basis of the needs of local people and of the country), taking note of their values and capacities and what is manageable and feasible in the particular circumstances in the country. This needs to be accompanied by an improvement on the part of the donors in matching their priorities with those of Nepal.

2.7 The lack of an adequate project planning and management system that involves rigorous

review of project formulation, implementation, supervision and evaluation, has also prevented the economy from deriving maximum benefits from aid-financed investments. This has led to the implementation of many projects, which do not reflect people's requirements, values and capacities, resulting in inefficient resource allocation and ineffective use of aid resources. In many cases, sustainability and the operation and maintenance aspects of the projects were altogether lost sight of. A large number of projects, as noted, suffer from the lack of ownership by the government and by the people whom the projects are intended to benefit. Further, in the

absence of adequate appraisal, foreign aid has been frittered away on many smaller projects for which such aid may be unnecessary or even undesirable from the country’s perspective.

2.8

Nepal receives aid from a large number of donor agencies and organizations. In the

absence of prioritization based on sectoral and national needs and effective donor coordination on the basis of such prioritization, there have been difficulties in coordinating and establishing

complementarities between these aid channels. Each donor agency may have its own policies, priorities and perceptions of Nepal's needs which at times are not only divergent but also are contradictory to each other. Foreign aid does not always flow into the sectors where it is most needed; and as a consequence there are significant resource gaps in many sectors. It is quite difficult and at times, time-consuming to bring about a convergence in diverse donors’ perceptions. Thus, aid coordination has become a burdensome and cumbersome task.

2.9 An increasing concern especially from the Nepali perspective is the changing

composition of foreign aid. Of the total foreign aid received in 1999, capital assistance accounts

for only half, and technical assistance accounts for around 40%, with the residual 10% being balance of payments support and emergency and relief assistance. As noted earlier, the share of technical assistance has increased rapidly. Whether this is the most appropriate allocation of foreign aid resources is a matter, which needs to be reviewed by both donors and Nepal.

2.10 Technical assistance has fallen short of the contribution that it could have made, largely

due to excessive reliance on foreign expertise. Technical assistance linked to capital assistance has so far not made optimal use of technical manpower available in the country. A result of this, there has been the adoption of inappropriate technologies. Even in freestanding technical assistance, there is a tendency to depend excessively on foreign expertise instead of tapping local technical capacities, with a view to upgrading local institutions. Technical assistance, especially when obtained through loans instead of grants, creates enormous burdens for the future.

2.11 Foreign aided projects often involve choices in the types of technologies utilized at

various levels of their operation, whatever the sectors they are in. Nepal still does not have an appropriate and effective mechanism to evaluate technology aspects of foreign assistance, particularly capital assistance. This is especially true of turnkey projects where the decisions with regard to technology to be used are entirely determined from outside. This has implications on the long-term sustainability of such projects and their repair and maintenance. There is inadequate or no provision for R&D with a view to minimizing costs and improving the quality of the products.

2.12 The conditionalities that are linked to the provision of foreign aid vary between donor

institutions and projects and programs. The practice of enforcing conditionalities tied to aid present another set of problems in terms of making best use of available foreign resources. Further, the practice has constrained the use of appropriate and less costly technology, materials and services. On account of various policy-related and procedural conditionalities, which are at

times not compatible with the prevailing situation and the needs of the country, aid has had not only a limited beneficial impact, but has at times run counter to the outcomes expected from some projects. While donors need some conditionality, they need to be looked at and agreed jointly by the donors and the government. And, the formulation of and adherence to sectoral program frameworks, as suggested below, would help to minimize and rationalize such conditionalities.

2.13 Disbursing the aid committed to Nepal has been a slow process. The weaknesses in the

country’s institutional capacities have contributed to this phenomenon. However, delays have also occurred as a result of the policies, practices and procedures of donor institutions themselves, which have not recognized the limitations inherent in Nepal. Taking account of institutional capacities within the country and planning projects on that basis would provide for more realistic disbursement patterns. It is not only a matter of refining procedures but also a problem, which starts with the conception and design of projects themselves; and these aspects need to be improved.

2.14

Sizeable amounts of foreign aid have been flowing through various Non-Governmental

Organizations. While these organizations are making an important contribution, they have also established their own priorities and methodologies of operation, without adequate regard to development priorities of the country, and also to the overriding need to create sustainability. Their resource use seldom reflects national priorities, nor are they transparent in terms of the sources and amounts of resources utilized by them. To ensure greater consistency with national priorities, better use of aid resources, and greater transparency, it is necessary to improve the reporting and monitoring of resources channeled to such organizations. A similar problem is that the aid resources available to HMG have not all been reflected in the budget. Donors at times make direct payments to project accounts without informing the related Ministries or Departments. As a result, there are difficulties in updating the records and ensuring transparency and accountability in such transactions.

2.15 Project implementation capacity of the economy is less than satisfactory.

reliable information system and the absence of regular supervision and monitoring are major deterrents to the smooth implementation of programs and projects. As a consequence, most projects suffer from time and cost overruns.

Lack of a

2.16 Gradually over the years, Nepal’s stock of outstanding foreign debt and its debt servicing

obligations have risen, as a result of utilizing foreign loans. Although these loans are concessional

in nature with high degree of grant element, they still constitute a growing burden on the budget. Therefore, Nepal has to be highly selective and productive in utilizing such loans (see below).

These are some of the major problems which have had hampered the efficient and effective utilization of development aid. A major reason for this state of affairs has to do with the lack of policies and guidelines required for streamlining aid activities. It is natural that in the absence of such national perspectives and policies, development projects may at times be heavily influenced by donors' ideas and perceptions; and not fully related to local needs and requirements. The new foreign aid policy seeks to address these issues.

III THE CHANGING CONTEXT OF FOREIGN AID POLICY

3.1 Nepal has been implementing development programs and economic reforms, supported

by external assistance, for a long period of time, in the context of a development framework, which has evolved largely on the basis of international development experience, and inter-actions between global community and the government of Nepal. In the last decade, many major changes are evident, nationally and internationally, in the milieu and circumstances in which development cooperation is practiced. Notably, development paradigms themselves have undergone significant changes, with the phenomenon of globalization; the dramatic transformation in the role of the state, markets and civil society organizations; and increased emphasis on cross-cutting issues such as gender, governance, transparency and decentralization and so on. There is also recognition that economic and social issues can only be addressed effectively through linking up activities across sectors and themes, instead of compartmentalizing them through isolated projects and programs. These perceptions in turn have heightened the need for aid recipient countries to formulate carefully designed holistic strategies to combat poverty, focusing more on (poverty reducing) outputs and outcomes and more closely linking development projects/programs and activities to national and sectoral goals. To complement these initiatives, holistic approaches to foreign aid policy and development cooperation have become imperative for external donors also.

3.2

These trends, in varying ways, shape the nature and content of development cooperation

and foreign aid. Given these new trends and perceptions on the part of the international development community, and also of the development community in Nepal, it behoves the government to analyze and examine the fundamental premises that underpin the foreign aid policy of the country. Ineffective aid policies and practices, be it on the part of government or donors, can be damaging to good governance, while also having other major deleterious effects. Conversely, a foreign aid policy, which reduces compartmentalization, and improves efficiency and transparency, can make an important contribution to the development process.

3.3 Current development parlance has laid stress on partnerships in development between

donors and recipients. Unfortunately, small less developed recipient countries - such as Nepal - cannot match the sophistication and resources, both technical and financial, available to the donor

community, in order to become equal development partners. In the case of Nepal, donors claim

donor fatigue, and are also to some extent disillusioned by the slow and imperfect outcomes from development cooperation. This aspect is well documented. Similarly, although less documented,

disillusionment among the government and local stakeholders with the policies,

processes and practices of foreign aid. Therefore it is necessary that the foreign aid policy process is reinvigorated, so that there is greater mutual understanding between and among development partners and that realistic solutions are sought to a range of entrenched problems.

there is also

3.4 The government recognizes that globally agreed principles, conventions, policies and

frameworks increasingly guide development assistance from external sources. There is a large area of consensus and agreement on the development policies to be pursued, at national and international levels. Nepal has been a party to most of the international agreements, arrangements, and consensuses so far agreed upon. Nepal is committed to UN targets for poverty reduction, aiming at halving poverty by 2015. Nepal has also been a party to agreements arrived at global conferences on the environment, women, children, human rights and at the Social Summit. In developing Nepal’s development policies, and in utilizing foreign assistance, Nepal aims at achieving these internationally agreed measures and targets.

3.5 Nepal attaches the highest priority to reducing poverty. Half the people of the country are

below the poverty line; and as a democracy, the government is deeply committed to reducing poverty among those who are absolutely poor. Sustainable reduction of poverty can only be achieved through balanced strategies of development, which attach equal importance to economic growth and social investment. The aim is to make an impact in reducing both income and human poverty. Economic growth is an essential precondition to poverty reduction. Without it, other forms of public actions will not be productive. Equally, economic growth has to be accompanied by increasing social welfare. Social improvements in education and health themselves will make an important contribution to economic growth. The government has predicated its public interventions on the basis of creating a virtuous cycle of economic and social enlistment. Economic and social investments can both be productive and yield high returns within such a development framework. Especially for the reduction of poverty, foreign aid will have to be utilized within such a framework.

3.6 The Government also recognizes the importance of adapting its development policies in

line with the changing development paradigms, as well as the critical need to address the weaknesses and shortcomings identified earlier, which hamper aid effectiveness in Nepal. Accordingly, Nepal has undertaken several initiatives since the last NDF meeting, which are discussed in detail in a separate note. Of direct relevance to aid policy in this regards is the formulation of an Interim Poverty Reduction Strategy Paper (I-PRSP) in July 2001, the ongoing preparation of the Tenth Plan, (which will be the Government’s full PRSP), which is expected to be finalized in June, 2002 and the establishment of Poverty Alleviation Fund. The Tenth Plan is

expected to be a significant departure from past plans in that: (i) it focuses far more sharply in a holistic manner on poverty reduction as the primary goal of Government’s development efforts; (ii) It seeks to link development activities more directly with national and sectoral goals and targets and poverty reducing outcomes (rather than focusing simply on targets inputs and commitments as in the past); and (iii) It also seeks to achieve a greater degree of realism in terms of setting targets and aligning the resource framework and annual budgets in line with financial and implementation capacity.

3.7 While external assistance inflows need to be largely guided by longer-term development

perspectives, it is also necessary to take into consideration the short-to-medium term imperatives Nepal is facing. Two major elements in this regard are: (i) The challenge to internal security. Apart from slowing down development activity in remote areas, it has created new demands for security-related expenditures of an unprecedented nature; (ii) The downturn in the economy, which is partly a bi-product of the global recession, and partly the result of a constellation of unfavorable domestic events, of which the security threat is a major element. As a result, Nepal is now facing unprecedented budgetary pressures. Despite the government’s efforts to generate additional revenues, (significant post-budget supplementary revenue measures were recently announced, for the first time in the last two decades), domestic resources available for financing development activity will be severely constrained this year, as well as next year. This has necessitated adjustments in the Tenth Plan’s macroeconomic framework, even as the Plan is being finalized. Accordingly, to align the Plan with the realities of current fiscal situation and to protect its key priorities, the Government is now preparing, for the first time in Nepal’s history, a Medium Term Expenditure Framework (MTEF), which is being presented separately. The MTEF needs to be viewed: (i) Not as an alternative to the Tenth Plan, but as an operational tool to implement the Tenth Plan, by providing a bridge between the annual budget cycle and the Tenth plan framework; (ii) It also represents the first genuine attempt by the Government in recent years to prioritize the public expenditure program and to bring much needed realism to the annual budget allocation process; (iii) Equally important, it represents the government’s own initiative to the fiscal crisis. The key sector programs underpinning the MTEF are being are prepared and owned by the line ministries themselves, in collaboration with the Ministry of Finance and the National Planning Commission; and are expected to be finalized after extensive consultations with local stakeholders, to serve as the basis of sectoral programs in the forthcoming Budget. (iv) The I-PRSP, the Tenth plan and the MTEF would collectively represent a new poverty focused approach to public resource management; and in turn is expected to be the basis for a new compact between the donor community and the government on future assistance to Nepal.

3.8 It is against this backdrop that the present foreign aid policy document has been prepared.

This document is expected to shape the evolving pattern of Nepal’s relationship with her development partners, while at the same time guide all -- HMG, the civil society, and the donor community -- in making the best use of scarce resources for development. The policy is relevant both for the short, as well as for medium-to-longer term. But, as changes in the structure and in the important variables of the economy take place, the policy paper will need to be revised from time to time, in order to be responsive to changing needs and circumstances.

IV. GUIDING PRINCIPLES AND OBJECTIVES

4.1 Foreign aid policy is largely an integral part of a country’s development policies and

priorities. Unless the two are closely integrated, effectiveness and efficiency are bound to suffer.

Foreign aid is received from many donors institutions, and each one of them has its own approaches, policies, procedures and practices. Unless there is greater consistency and compatibility among the diverse sources of foreign aid, recipient countries such as Nepal will be

confronted with serious problems. Although there has been considerable progress in reconciling varying donor policies and practices, there are many aspects, which need to be improved. Nepal cannot afford parallel aid systems in various sectors, operated through compartmentalized projects and programs. The policy elements that follow are primarily aimed at improving the current situation.

4.2 The policies and strategies that are outlined in this document have been drawn from

accumulated experience of foreign aid projects and programs in Nepal. There is a significant cultural gap between donor institutions and those of Nepal. What works in one country may not in another. As a least developed country, Nepal lacks the capacities, both institutional and personnel. Therefore, project and program design and implementation methodologies have to take full account of these institutional weaknesses, as well as the tremendous challenges that confront implementing authorities. The policies that are outlined here is an attempt to take realistic account of these problems.

Guiding Principles

4.3 The objectives and priorities elaborated in

aid are guided by three broad

principles:

subsequent paragraphs with regard to foreign

- First, foreign aid will need to be directed towards achieving the over-arching national goal of poverty reduction. This will involve fostering economic growth by enhancing the productive capacity of the economy, as well as supporting critical social infrastructure needs. It should also include appropriate support for making the best use of the infrastructure base, which has already been created to further promote, expand and sustain the development process;

- Second, the role of foreign aid should not be viewed only in the context of supporting individual projects. It will need to be related to the needs and priorities at economy-wide and at sectoral levels, recognizing that sectoral policies constitute integral elements of the economy-wide policy; and individual donor assisted projects/operations will need to be consistent with the sectoral objectives.

- Third, the foreign aid policy forms an integral part of the overall policy of mobilizing resources for development.

The Objectives

4.4 HMG recognizes that foreign aid policy has to be guided by a long-term vision, but

should also incorporate the short-term imperatives of the country. For the longer term, this would imply that foreign aid would be effectively integrated into the overall resource mobilization framework of Nepal, to help finance and support Nepal's development endeavors, particularly to achieve poverty reduction goals. This is also important in the short term; but as discussed below, there are other considerations also which should guide the composition of

4.5 The broad objectives of aid policy, which are to be achieved through the adoption of

policies and strategies outlined below, include among others, the following:

i. To ensure the compatibility and convergence of foreign aided development activities with nationally determined development priorities. Through greater convergence between foreign aided projects and national priorities, aid supported activities can become an integral part of the overall development process.

ii.

To improve the quality, effectiveness and efficiency of foreign aid operations. A broad range of appropriate policies and practices on the part of Nepal and donors – in project selection, design, management, review, monitoring and evaluation – are imperative.

iii.

To enhance the contribution to poverty reduction through enabling higher rates of economic growth while ensuring distributional equity. This would require improved linkages with civil society organizations and the private sector, and also establishing complementaries between aid and other economic policies, and utilizing foreign aid more effectively to address issues such as governance, gender and the environment.

iv.

To facilitate the transition to a more equal partnership between Nepal and donor institutions. This objective is aimed at transferring the spirit of development partnership emerging at the global level to the country level dialogue and operations.

4.6

In light of rapidly evolving short-term needs of the economy and the importance of

mitigating the constraints undermining the effective use of aid resources, short-to-medium term

aid policy priorities are discussed in the next section. The longer-term considerations, which should guide external aid policy, are discussed in later sections.

V. AID PRIORITIES FOR THE SHORT TERM

5.1 The foregoing discussion highlights the frustrations of the donors and Nepali counterparts

with performance of external aid in Nepal. As noted, the Government in recent months has launched important initiatives to address these concerns particularly through the formation of a PRSP and MTEF, and associated changes in the budget allocation and management process. The PRSP/MTEF clearly tries to improve the focus of the public expenditure program, with the government taking the leadership in, and ownership of, the process. As noted, the MTEF is driven by a realistic assessment of resource availability -- the hard budget constraint -- in contrast to the previous “needs-based” approach; with the objective of avoiding over programming, (which has plagued the previous budget and plans), and has achieved a significant degree of rationalization and prioritization of development programs and activities. Although much remains to be done in the coming months, this is a clearly a new beginning on the part of the Government to tackle boldly the major impediments hampering the effectiveness of public expenditure and aid programs. In particular, winning political support for expenditure prioritization among the political leadership and other stakeholders who might be affected by the process, remains a challenge.

5.2 The MTEF process will have important implications not only for the Nepalese

counterparts, but also for the donor community. At this time, it is possible to briefly point out

what the short-term implications are likely to be for foreign aid. These would be discussed fully in the MTEF documentation when they are finalized.

(i)

The priorities in the MTEF will closely reflect the national priorities identified in the Tenth Plan/ PRSP. The donor community will need to respect and adhere to these priorities, if the persistent problem of “ donor driven” nature of development in Nepal is to be overcome. Where there are differences of views, donor community and the Nepalese counterparts will need to enter into a pro-active and productive dialogue in the coming months to resolve these differences.

(ii)

The key message of the MTEF process is that Nepal needs to consolidate its development program at this time in line with the realities of resource availability. This would mean

that few new projects can be accommodated at this time, i.e. what is needed at this time is not simply more project aid. As the resource situation and implementation capacity improves over the following two years and as ongoing projects are completed, there will be scope for new projects, provided they are within the national priorities identified by the Government.

(iii) There will need to be greater emphasis on sectoral programs, since an important goal of the MTEF and the PRSP would be to undertake those activities, which have a more direct impact on national and sectoral poverty alleviation and growth objectives. In funding sectoral programs, basket-funding approaches would be encouraged. However, it will still be possible for individual donors to take up stand-alone projects, so long as they fit within the sectoral priorities (see below).

(iv) The MTEF and the PRSP, as noted, focus more on outcomes and outputs and service delivery aspects of key programs, instead of the traditional input focused approach. A major feature of the new approach is that it emphasizes better use of existing capital/investments through adequate funding of essential operational and maintenance activities, instead of focusing simply on new investment. (To facilitate such a shift and to monitor the effective utilization of funds for recurrent activities, the Government will be introducing important changes in budget classification). External aid would be expected to assist such a shift by providing support for essential operational and maintenance expenditures and similar recurrent components, which would maximize benefits and service delivery.

(v) The most important shift that would need to occur in the short term is in the composition of aid. In the present fiscal situation, the government will be channeling a substantial part of its revenue surplus to financing security needs, which are a major priority without any doubt. This would however seriously reduce counterpart funding available for funding development activities. The need of the hour therefore from Nepal’s perspective is budget support, in the form of cash grants and loans, and sectoral/program support. The expenditure prioritization and sectoral focus of MTEF would now provide a framework for this purpose, which was lacking earlier in Nepal.

(vi) The Government is acutely aware that it would need to reassure donors about “ fungibility concerns”. Indeed, it recognizes that improving the budget allocation process through the MTEF is only one side of the coin, and that it needs to improve implementation and expenditure monitoring at all levels. Over the coming months, the government is expected to finalize such arrangements, in consultation with, and support from, donors. A Country Financial Accounting (CFA) framework with assistance from multilateral institutions, together with budget classification improvements noted earlier, would be initiated for this purpose. In addition, technical assistance programs will need to be strengthened, with support from donors, at critical levels – for example in line ministries and at the level of district and local institutions-for enhancing the implementation, monitoring and accountability aspects.

VI. AID PRIORITIES FOR THE LONGER TERM

6.1 In view of limited human, economic and other resources relative to persistent and

growing claims on them, Nepal cannot afford to undertake an unlimited number of investment programs. Hence, as a matter of policy, the country has to remain very careful and selective in

making investment decisions. In this context, the guidelines for aid policy for the longer term will not be significantly different from those applicable for the short term.

6.2 Foreign aid has to be channeled to those sectors and sub-sectors, which have been

identified by the government as national priority areas. In broad terms, these include infrastructure development (energy, transport, tourism, science and technology), agriculture, irrigation and forestry, including the environment, human resource and social development, education, health, population, and to specific activities focusing on poverty alleviation, employment promotion and development of backward regions. Within these broad sectors and issues, emphasis will be placed on areas such as rural infrastructure development including rural electrification and rural roads and transport, minor irrigation and agricultural extension and crop diversification, and basic and technical education, public health, access to drinking water and managing the population problem. Foreign aid will be utilized in these sectors and sub-sectors to address primarily the issues of economic growth and poverty reduction, as well as capacity building.

6.3 Foreign aid would also need to be channeled within the priority sectors/sub-sectors,

toward those activities that have relatively high economic and social returns. Efforts would be made to keep the inflow of foreign aid consistent with, and reinforcing economic reform programs. Priority projects would be selected on the basis of predetermined objective criteria.

6.4 There are obvious linkages between and among priority sectors and related issues.

Assistance for priority sectors/sub-sectors/ activities would be identified in a manner that can maximize the gains from such assistance, keeping in mind the spill-over effects on others also, so that assistance in one area can also provide benefits to other sectors/sub-sectors/areas. In utilizing foreign aid, an essential policy consideration would be to ensure that the complementarities and inter-relationships between projects and programs are clearly established and that the synergies, which can be derived from collaborative approaches, are fully realized. Channeling of aid has to a large extent been compartmentalized and fragmented through focusing on individual projects and programs. Policies will be designed to overcome such compartmentalized approaches through a more holistic and integrated approach. In doing so, cross-cutting issues which impinge largely on current poverty patterns – gender, environment, and efficient forms of government and management-will also be given close consideration in the design of projects and programs. However, the government will not encourage developing discrete or individual projects around such cross cutting issues. And, rather than making such aspects the major investment components of assistance, all cross-cutting issues would be built-in within the priority investment programs. An important policy consideration in channeling foreign aid will be to explore inter-linkages between development issues.

6.5 Efforts will be made to look at the aid needs in the priority areas/sectors within the

context of sectoral frameworks, which will take into account not only “development/investment” needs, but also recurrent expenditure requirements (for O & M etc.) to maximize he benefits from existing assets. Donors will be encouraged to finance sectoral needs (both current and capital) in accordance with these sectoral needs. As noted, key projects/activities in each of the priority areas will be identified and ranked in terms of sectoral priorities, and will be subjected to careful scrutiny and evaluation, so that donors who would wish to take up free standing projects would be able to do so within a sectoral context.

VII. MAJOR POLICIES

With a view to meeting above objectives, the following policies will be pursued:

7.1

Concessional Loans: Loan assistance would be utilized selectively, after careful

scrutiny of the purpose, content and benefits of such projects and programs in order to reduce the burden of external debt, while contributing to accelerating growth and meeting socio-economic objectives. Nepal would encourage a closer partnership between the government and multilateral donors so that they can jointly examine the implications of these loans in terms of their contribution to economic and social development. Measures to be adopted in this regard include:

(i) utilizing foreign loan assistance in projects and infrastructure development promising high returns on investments, (ii) analyzing the various implications of each new loan before accepting it, (iii) focusing loan assistance on areas that help generate private sector activities and promote external sector transactions that enhance the foreign exchange earnings capability, (iv) exploring ways of reducing the loan liability of HMG by protecting against exchange rate fluctuations. To reduce the potential debt burden the Government will also: (v) stop the use of loans for study visits, (vi) minimize the expenditure on consultants and foreign experts out of loan assistance, (vii) not take any commercial and suppliers’ credits, and (viii) not guarantee foreign loans for HMG-owned or other institutions.

7.2 Grant Aid: Since grants will not burden the future generations and also do not constrain

the already tight fiscal structure of HMG, Nepal needs to mobilize aid more in the form of grants. Therefore, the Government’s policy will be to seek grants first and, in the event grant assistance is not forthcoming, seek highly concessional loans. Action will be taken to facilitate arrangements to associate concessional loans with grant finance whenever that is appropriate. Many project and program components are more appropriate for grant financing than concessional financing in least developing countries like Nepal. Technical assistance for project design, institutional and capacity building, technical backstopping, and project monitoring and review, are more suitable for grant financing than for concessional loans. Co-financing arrangements through grants shall be emphasized for financing expenses of overhead and technical support of projects.

7.3 As in the short term, program support (as compared to project financing) will be

necessary in the longer term also. Such support will be sought in the context of sectoral and/or macroeconomic programs, as well as for budget support under appropriate circumstances.

7.4 Technical Assistance: Technical assistance has to make a sustainable contribution to

Nepal’s development process. Reliance on technical assistance and expatriate consultants shall be gradually reduced by building domestic institutional capacity through the appropriate use of human resources, facilitating the transfer of expertise and technical know how, and appropriate and selective use of technical assistance. Technical assistance would be especially focused on facilitating the implementation of large projects, carrying out reforms in the specific socio- economic sectors, and the functions related to developing strategic directions of the country, for example, in building capacity at various central and local government levels for formulating, implementing monitoring development activities. Selectivity would be pursued while opting for technical assistance in the other areas. No loans will be used for technical assistance.

7.5 There are broadly two types of technical assistance – free standing technical assistance

and project-related technical assistance. In regard to the former, many donors have increased the local component in sourcing such assistance. Through increased recourse to local talent and expertise, technical assistance helps to build the capacities of local institutions and personnel, in addition to providing financial support to the country. However, this process has further to go, and donors will be encouraged to hire local resources wherever possible for free standing technical assistance to build up local institutional and technical capacities.

7.6

With regard to project-related technical assistance, the policy of the government will be

clearly to stimulate and encourage the greater use of local consultancy expertise when designing projects. Apart from building their capacities, this would also contribute to enriching the quality

of projects and programs, by taking account of local circumstances, local needs and capabilities, and by selecting more appropriate forms of technology which are sustainable in the longer term. Donor institutions should view this as an effort by government to enhance the quality of the development process and for ensuring more cost effective and higher yielding investments through the appropriate use of relevant personnel and technologies.

7.7 Two other aspects of technical assistance need to be addressed. Nepal has received the

services of large number of volunteers, and their contribution to the country’s development process is appreciated. However, more efforts are required to improve the relevance and quality of volunteer involvement. The government will identify specific areas in which volunteers can be productive, and on that basis, donors will be approached to recruit volunteers. Another aspect of technical assistance is TCDC. The government expects to encourage the expansion of TCDC practices, and to obtain more technical support from regional institutions. Donors will be encouraged to utilize regional technical resources, and to source their technical cooperation activities from third countries especially from the region.

7.8 Revenue Mobilization: For a low-income country such as Nepal, opportunities for

increased revenue mobilization are limited. In this context, foreign aid can make an important contribution to augment the resource available to the country for development purposes: It can directly supplement government revenues, as noted earlier. It can also indirectly help the government to mobilize additional revenues in several ways: (i) Technical assistance to help improve capacity of the tax administration is one way. (ii) It can help expand the revenue base through its contribution to accelerating economic growth. This explicitly calls for policies by government to select projects, which will stimulate economic growth in the short and medium term. This will be an important aspect of the policies determining the selection of projects. (iii)

Foreign aid can also be used to finance projects that directly bring increased government revenues, for example in the energy sector. Accordingly, consideration will be given to using foreign aid to finance projects, which will bring about improvements in the domestic revenue mobilization capacity by raising GDP and employment, and achieving high economic growth targets.

7.9 Under Utilized Capital Stock: Investment activities in the public sector have not

generated returns and revenues at an appropriate level. For many reasons – scarcity of financial resources, shortcomings in management, delays in repairs and maintenance, inappropriate investments – the capital stock owned by the public sector is under utilized. Foreign aid can be a catalyst to improve the efficiency of utilization of the country’s capital stock, especially by financing critical inputs, supplies and other relevant recurrent expenditure items, including care and maintenance. Small-scale interventions at critical points in sectoral operations can also have immediate benefits. Foreign aid will be sought for this type of activities aimed at increased efficiency and better use of the existing stock of capital. Promoting program and commodity

assistance of this kind will be an important aspect of the foreign aid policy.

7.10 Building National Capacity and Partnership: Foreign aid would be utilized to

strengthen national capacity by encouraging the Nepalese to assume leadership role in project management. Partnership among the government, private sector, the civil society and NGOs and the donors would also be fostered to strengthen domestic aid management capacity. Building effective partnership with stakeholders in each stage of project planning and implementation will help maximize the benefits from projects, enhance their sustainability, reduce corruption, and

strengthen governance. In addition, the public-private partnership helps develop the private sector and eventually raise national capacity in managing development activities.

7.11 A Framework for INGOs: INGOs are valued development partners of the country.

They have capacities and experiences elsewhere which can be transmitted to Nepal, especially for upliftment of rural and remote areas of the country. They also have a comparative advantage in some areas such as delivery of health services, though less in others. While these advantages are recognized, given the large number (over 100) of INGOs currently operating in Nepal, it is clearly vital to have effective monitoring and reporting of these operations. The government has a right to know what resources are being brought in by INGO and are used for what purposes both for reasons of transparency and for planning (often overlapping) sectoral programs and activities. Accordingly, external resources channeled through INGOs would be monitored and their use would be made transparent as well as accountable to HMG and the people whom the INGOs are expected to serve. This would be achieved by: (i) using a one-window system to bring about simplicity in administration so as to reduce administrative hassles in the matters relating to the INGOs' registration, renewal and use of facilities, (ii) utilizing the Social Welfare Council as the one-window system for the INGOs, with the Council becoming the focal point for their activities, (iii) enhancing the capacity of Social Welfare Council to regulate and monitor NGO activities, (iv) ensuring that all INGOs enter into general agreement with the Social Welfare Council. Arrangements would be made to enter into project agreements with the concerned entities under the framework of the general agreement. (v) establishing compulsorily linkages with sectoral agencies, District Development Committees (DDCs) and Village Development Committees (VDCs) by the INGOs for carrying out their operations, (vi) requiring INGOs to comply with tax laws and audit requirements, (vii) requiring to make maximum use of the local human resources and other resources, (viii) ensuring that funds to INGOs do not come out of country pledges of the donors and also INGOs do not carry out fund-raising inside Nepal in any way, (ix) emphasizing that INGOs carry out their programs in partnership with local bodies and local NGOs, instead of doing it directly by themselves, (x) providing equal treatment to local NGOs by the INGOs and selecting the local NGOs for partnership on the basis of transparent and objective criteria, and (xi) encouraging INGOs to work in rural and remote areas.

7.12 Ensuring Leadership and Ownership of HMG: Ownership of foreign aided

development activities by HMG and beneficiaries will be ensured for enhancing the effectiveness of aid. In this context, the role of donors will be promoted as facilitators and supporters in the development process. Measures would include: (i) transfer of responsibility to the national stakeholders for project preparation and implementation, (ii) provide equal treatment to fully HMG-funded projects and donor-assisted projects in terms of budgeting, ownership and implementation, as well as expenditure reporting and accountability. (iii) streamline project implementation by discouraging the establishment of separate Project Implementation Units (PIU) or Development Boards or Committees, (iv) encourage donors to help enhance national ownership, and (v) expand and strengthen the decentralized planning and implementation system. Through increased ownership of development activities and proper repair and maintenance of projects, sustainable development would be ensured. It would also help reduce corruption, build

capacity and strengthen governance.

7.13 The Private Sector: The last decade has witnessed a major change in the role of private

sector in the national economy. It now plays a leading role in stimulating economic growth. Foreign aid has largely assisted the public sector. However, this should not preclude the greater engagement of the private sector in the design and implementation of foreign aided projects and programs. Particularly in capital assistance projects, the private sector can play a more extensive and expanded role in making technology choices, through consultancy and subcontracting arrangements. Foreign aid would be utilized as an important tool for private sector development

in consonance with the spirit and framework of economic liberalization. Foreign aid that would run counter to the objective of sustained development of the private sector and promotion of domestic and foreign private investments will not be encouraged. The private sector can also be more involved in co-financing arrangements of selected capital assistance projects, including mobilizing resources from foreign investors, and in generating complementary investments to those infrastructure activities being funded through foreign aid. The early involvement of the private sector in projects and programs will be sought so that they can explore complementary investment opportunities. The policy stance would be to provide priority to the private sector in making investments. HMG should step in only when private sector alternative is not available. The government will demarcate specific and feasible roles for the private sector in Nepal to be intensively engaged in foreign aid processes.

7.14 Role of Civil Society: Civil society organizations (CSOs) and NGOs are vital partners in

Nepal’s development process. They interact and interface with foreign aid operations at various levels. They are key interlocutors between the people of Nepal and government and donors on various aspects of foreign aid issues such as on the environment. They are also partners in various aspects of foreign aid operations especially in the rural areas. Large numbers of community groups are involved in various parts of the foreign aid structure in Nepal. They have built up local partnership arrangements with foreign aided projects and programs. The role of the UN System in stimulating social mobilization and involving civil society has been an important feature. INGOs have established multifaceted linkages with CSOs and local NGOs, although improvements are required. The government expects to stimulate greater involvement of CSOs and NGOs in the foreign aid process, from the time of project selection to project implementation. Their views will be encouraged through a greater transparency and sharing of information. They will be facilitated to contribute their views on development priorities and opportunities and implications of foreign aid to their communities.

7.15 International Policy Dimension: Policies and practices of donor institutions in Nepal are

at least partly a reflection of the various recommendations, prescriptions, and decisions arrived at global and multilateral forums. While there have been major improvements in the direction and quality of the development dialogue and of development cooperation in particular in these forums, the influence of ideas and experience of developing countries, and particularly of least developed countries have not been evident to any strong degree so far. LDCs such as Nepal lack the capacity of the developed donor countries and of donor led institutions. However, Nepal has the opportunity to make a more important and decisive contribution to international and multilateral deliberations on these issues, drawing on its accumulating experience with development cooperation. Nepal’s contribution, to be effective and relevant will have to be made on the basis of objective analysis of the successes and the shortcomings of the development experience in the country. This will be an aspect of development cooperation policy that will be stressed from now on. Local experts and institutions will be enabled to play a more active role in evaluating Nepal’s experience and formulating their ideas, which can then be provided as inputs into the multilateral system of deliberations.

7.16 Soliciting an increased level of cooperation: HMG would pursue a policy of enlisting

strong support from donor communities for achieving its development objectives. HMG believes that an enhanced level of mutual understanding can further strengthen the process of development cooperation. While Nepal on her part would try to present its needs and aspirations, performance and problems to the donor communities through, but not limited to, a series of institutional linkages that currently exist, the understanding of the donor community is solicited particularly with respect to the following: (a) Sensitivity: Greater sensitivity to Nepal's unique geographical and other characteristics which will have an impact on an independent development policy Nepal wishes to pursue. (b) Selectivity: HMG wishes to be selective and focused in favor of areas which

could contribute to enhancing the living standard of people. Donors' mutual coordination and specialization on the basis of their respective comparative advantages could greatly facilitate HMG effort in " internalizing" the development process. (c) Avoiding Trial and Error Methods:

HMG wishes to avoid costly practices of experimentation and tests in technology or in other fields. (d) Working together hand in hand with Civil Society: HMG wishes to continue to work together hand in hand with civil societies and other beneficiaries, sharing knowledge, experiences, and resources for broad based development process to take its root. (e) Maintaining financial discipline: As a part of an ongoing effort toward transparent reporting, internationally recognized accounting, monitoring and auditing practices would be pursued to maintain financial discipline. Auditing the activities financed by donor funds by the Auditor General of Nepal would be encouraged; (f) Transparency in Fund Transfers through INGOs/NGOs: HMG wishes to be informed and reported to on a mandatory basis, about the aid mobilized and utilized through the INGOs/NGOs; (g) Reflection of Financial Sources in the Annual Budget: Cooperation is also solicited to ensure that all aid resources are made transparent and are reflected in HMG annual budget; and (h) Improving Donors’ Procedures: An important part of the overall strategy for more effective foreign aid will be the reform and improvement of donor procedures. Negotiations will be undertaken with donors to harmonize and standardize treaties and agreements entered into with them.

7.17 The above policies are important to achieve the objectives of the foreign aid policy as

well as to deal with problems that have been impediments to the effective utilization of foreign aid. Foreign aid policy planning is as important an element of the overall policy planning of the Tenth Plan. Accordingly, appropriate strategies and policy instruments will support these policies.

VIII. MAJOR STRATEGIES

In order to achieve these objectives the following strategies would be deployed for implementing the policies enumerated above.

8.1 Formulation of Economy-wide and Sectoral Perspective Plans: For proper allocation

of resources, it is desirable to formulate economy-wide and sectoral perspective plans. These plans will clearly identify sectoral priorities as well as internal and external financing needs at sectoral levels, and relate them to the overall economy-wide plan and financing policy. HMG will encourage the sector program approach to address the needs of specific sectors or sub-sectors. As noted, the sector plans are expected to encompass: (i) an approach that is truly sector-wide in nature, which is consistent with national goals and cover all relevant public expenditure components; (ii) a clearly articulated sector strategy; (iii) appropriate role for, and assistance from donors; (iv) implementation arrangements made in consultation with relevant donors to the extent possible; (v) long-term technical assistance needs; (vi) acceptance by partners of joint accountability for program outputs; and (vii) commitment of donors to finance the program either through program support or project support, as discussed above.

8.2 Ensuring Transparency and Accountability: Transparency in foreign aid management

will be ensured to enhance the benefits of aid-supported activities, reduce inefficiencies and distortions, combat corruption, assist in decision-making and make policymaking accountable. Similarly, financial discipline with respect to aid-related activities would be strictly followed to enhance the confidence of the people in foreign aid management, realize maximum benefits and control the misuse of resources. The relevant mechanisms are: (i) make information available to the interested people about the cost and source of finance of each activity and component of

foreign-aided programs and projects; (ii) facilitate public flow of information on decisions made with respect to the selection of experts, consultants and key project staff, procurement, sale or

auction, pre-qualification, contract awarding, and with respect to criteria used, individuals involved and processes followed in decision making; (iii) make available to the interested people pre-feasibility, feasibility, audit, evaluation, performance and other reports of aid-supported activities; (iv) reflect all aid resources in the budget and utilize them through the budgetary process; (v) facilitate and assist public inquiry, and set specific time periods for handling requests, dissents and complaints; (vi) strictly enforce legal measures on corrupt practices, administer reward and punishment rules, and fully observe codes of conduct in public services; (vii) vigorously prepare, strictly implement and effectively monitor action plan to prevent economic irregularities in aid-supported activities; (viii) select clean, capable and bold personalities for key positions; (ix) make mandatory disclosure of information on commissions paid to agents; (x) encourage the role of media, civil society organizations and individuals in controlling corruption and exerting pressure to take action against culprits; (xi) eliminate discretionary powers embedded in rules and laws; and (xii) make no exception to taking legally prescribed actions against corrupt persons.

8.3 Enhancing the Quality of Aid: One of the major objectives of the government is to

enhance the quality of aid. Regular investigative studies, for example joint reviews with the concerned donors, would form part of this strategy so as to learn from experience and disseminate the best practices. Further, the productivity and benefit of aid shall be maximized to enhance its impact on economic growth and poverty alleviation. While accepting aid, a through scrutiny of associated conditionalities would be made to ensure that these help and not hinder the smooth implementation of the projects. In this context, sufficient analysis and consultation with stakeholders will be carried out. Some necessary steps to be taken are: (a) to examine conditionalities with respect to critical goals of the project, development strategies, policies and the country's realities, (b) to obtain support and commitment of all stakeholders to fulfill proposed conditionalities, (c) to secure formal approval of the competent authority in the case of policy- related conditionalities, and (d) to design conditionalities in compatibility with the executing agency’s institutional capacity.

8.4 Strengthening Aid Coordination: Effective aid coordination constitutes another

important element of the strategy in order to channel aid in accordance with development policies

and priorities, and increase efficiency, effectiveness, and coherence in aid management. The government will play the lead role in aid coordination and management. The MOF, NPC and line ministries will abide by established practices to improve the mechanisms of aid coordination. Coordination of donor activities will be undertaken at the national level, sectoral level, at the regional level and also in relation to key development issues. In this context, joint chairing of sectoral coordination meetings by the concerned line ministries and donors will be encouraged. MOF and NPC will improve their systems of record keeping of donor funded activities, classified on the basis of appropriate categories, which will enable the provision of information for policy analysis and management of projects funded by donors. Databases will be set up, building on current available information within the various units of government. The capability of Ministry of Finance (MOF) would be strengthened to enable it to efficiently play the lead role in donor coordination, and to secure support from all stakeholders in aid coordination activities.

8.5 Project/Program Identification, Selection, Design and Securing Sustainability:

Sustainability of foreign-aided projects will be ensured by paying greater attention to considerations of appropriateness ownership and sustainability. Rigorous project analysis would be undertaken to establish appropriateness and sustainability. All projects shall be examined from social, economic, financial, managerial, technological and environmental perspectives. Some relevant measures would be: (i) to eliminate unproductive and redundant projects and focus on key development areas; (ii) to select only those projects that meet development and sustainability criteria; (iii) to establish sector wide and nationwide merit order of projects on the basis of

relevance, potential benefits, efficiency and effectiveness; (iv) to allot aid resources according to the order of merit of projects; (v) to link new projects to utilize the stock of past investments, (vi) to match donors' priorities and comparative advantages with program needs in mobilizing aid; (vii) to design projects at an appropriate level of technology that can be adapted and mastered in Nepal; (viii) to base project design on existing and potential strengths of local institutional and administrative capabilities, (ix) to make activities environment-friendly; as well as cognizant of gender issues and cultural and institutional sensitivities; (x) to involve beneficiaries, stakeholders and civil society at every stage of the project cycle; and to obtain their full support and commitment for implementation, particularly in relation to local level projects.

8.6 Create a Foreign Aid Management Information System: Keeping in view the

importance of foreign aid related information for monitoring and evaluation and for policy planning purposes; an information base would be created, regularly updated and disseminated. The database would include information, among others, on the costs sources and types of aid financing of each activity and component of foreign-aided programs and projects, disbursement performance, terms of assistance, debt-servicing obligations etc.

8.7 Promoting Institutional Effectiveness: Measures would be undertaken to promote

institutional effectiveness of foreign aid related institutions. Such measures include strengthening project implementation capacity of institutions; preparing and implementing human resource development plans based on the objectives and work characteristics of each aid-supported activity, deploying personnel in key positions strictly on the basis of expertise, integrity, capability and commitment; defining clearly the authority and responsibility of project staff and so forth.

IX. MAJOR POLICY INSTRUMENTS AND INSTITUTIONAL FRAMEWORK

Major Policy Instruments

9.1 Policies and strategies can only be made operational through a series of policy

instruments that are pragmatic and implementable. An important requirement in this regard is that there is clear linkage between policies, strategies, instruments and the institutional framework required for translating policy objectives into reality. In the absence of proper

identification of appropriate policy instruments and the institutional framework, these policies and strategies would largely remain unimplemented.

9.2 Adhering to Prudent Resource Allocation and Management Procedures: Aid

effectiveness depends, inter-alia, on realistic budgeting, prioritization of public expenditure

programs and screening of projects. In this respect, special attention will be paid to the improvement of the budget formulation process as follows: (a) The linkages between annual budgeting and periodic plans will be further strengthened through co-ordination of activities among MOF, NPC and line ministries, through the MTEF process discussed above. (b) Budget allocations will follow clearly defined priorities and ranking of projects in terms of their potentials for achieving sectoral and national development targets. Adequate considerations will be given to forward planning for resource needs of on-going projects and programs so as to complete projects by stipulated times and to avoid cost and time overruns, and (c) In order to avoid over-stretching of the development budget, rigorous project screening and evaluation for new foreign-aided projects will be made mandatory before they are included in the development budget.

9.3

Joint Programming Approach: Donors will be encouraged to undertake joint

programming of development assistance in order to channel resources to priority areas on the basis of their preferences and excellence and to agree on joint funding in the case of large projects requiring multi donor involvement. This approach is also useful in avoiding duplication of efforts and developing effective partnerships for development. In cases where disbursements of aid resources fall below expectations, joint recipient - donor investigations would be undertaken to look into the causes responsible and suggest remedial measures.

9.4 Effective Project planning and Implementation: Project planning exercises would

be undertaken at the beginning of the project cycle. Such exercises would focus among other things, on the justifications of projects, the extent of foreign aid resources required, implementation schedules etc. and would cover all key aspects of project formulation, identification, selection and monitoring and evaluation. Institutional capacity for project planning exercise would be strengthened.

9.5 HMG will redouble its efforts to improve implementation of projects financed by

domestic and foreign resources by (a) making counterpart funds available in time, (b) decentralizing decision-making authority all the way down to the project or program managers in the field, and holding them responsible for performance, and (c) standardizing

bidding document to avoid procurement problems.

9.6 Improvement in Project Evaluation, Impact Study, Supervision and Monitoring:

Rigorous project evaluation, as well as impact studies of at least major projects, would be undertaken. A strong feedback mechanism capable of incorporating voices of stakeholders and interested parties would be established. A system of "public hearing" on impact study reports of the projects would be initiated. A reasonable number of aid projects implemented under each sector will be studied on a periodic basis by independent groups of experts. Supervision as well as monitoring of the project implementation will be strengthened and established wherever necessary in order to avoid problems and deliver expected benefits. Toward making supervision and monitoring effective, efforts would be made to create project-monitoring committees at operational level.

9.7 Encouraging a "Common Pool" Approach: HMG will encourage a "common pool"

approach where co-financing arrangements are involved so that implementing agencies are not bound to submit separate reports as required by multiple donors and the limited capacities of institutions are not over-taxed. The recently developed basket-funding approach that has a simpler reporting format applicable to every individual donor in the consortium will be put into operation. In this model, the cost sharing of individual project components has to be mutually decided between donors and HMG. It requires HMG to assume full ownership in program execution. HMG shall be made accountable for program outputs and the use of funds. However, the government would also allow separate stand-alone financing of projects, as usual. As noted earlier, such stand-alone projects will still need to fit in with sectoral priorities; and will be entertained only in the context of such priorities.

9.8 Strengthening Financial Management: The financial management of foreign-aided

projects will be strengthened as follows: (a) Financial disbursement will be closely linked to comprehensive reporting of expenditure by spending units, including indicators of physical

progress of projects. (b) In foreign-aided projects/programs, submission of reimbursement claims on a timely basis will be ensured. (c) Audit reports will be prepared within six months of the completion of the fiscal year. Delays in submission of expenditure statements will be

penalized. (d) Retrospective financing in any foreign-aided project will not be allowed unless and otherwise agreed with the concerned donor in advance, (e) Financial accountability system will be developed, and (e) The budget release process and its criteria will be made fully transparent.

9.9 Improving Disbursements: Mechanisms will be identified to increase foreign aid

disbursement, in order to reduce the gap between the commitment and utilization of aid funds. In order to address this problem, HMG will make necessary arrangements to reduce delays involved at various stages. In this respect, top priority will be accorded to making

project management more efficient, by addressing bottlenecks and problems, which hamper project managers. Likewise, reimbursement procedures and practices will be reviewed and actions will be taken to speed up the process.

9.10 Improving Procurement: HMG recognizes that sound procurement policies and

practices are essential to fully utilize funds. HMG will make the procurement procedures more transparent. It will work toward establishing effective country procurement systems consistent with internationally accepted principles and practices as set out, for example, in the UNCITRAL Model Law on Procurement, the European Directives, and the World Trade Organization Agreement on HMG Procurement. The gap between the country’s regulatory

and financial framework for procurement and donors’ procurement guidelines and rules will be reduced to the extent possible.

9.11 Procedural Improvements: Several procedural improvements would be introduced

during the period to enhance the effectiveness of foreign aid, both grants and loans. These include, among others, (a) an effort to rationalize and make uniform tax exemptions and other facilities including immunities provided in relation to aid-supported activities; (b) introduce clarity in the terms and provisions of treaties, agreements and understandings previously entered into with the donor countries and institutions with a view to improving efficiency and effectiveness of aid through standardization, coordination and uniformity in external resource management; (c) establish criteria for the acceptance of external aid particularly loans, in the light of the country's rising public debt burden, as noted earlier.

9.12 A detailed manual would be prepared to implement policies and strategies outlined

above, to guide the use of policy instruments and institutional framework to assist in the effective utilization of foreign aid. This would simplify and quicken the decision making process with regard to aid.

X. GOVERNMENT/DONOR INTERACTION AND DIALOGUE

10.1 The quality of dialogue between the government and donors will be enhanced through

several measures. Already, the formal consultative group for Nepal has been transformed into the Nepal development forum. Further action will be taken to make the forum the central venue for high-level policy discussions on development issues. Particular attention will be focused on linking up foreign aid issues with the broader development concerns of the country and of donors. The local aid group meetings, both at the general and the sectoral levels will be organized to take up key policy, strategy and implementation issues. Similarly there will be improvements sought for discussion at the thematic and sectoral levels.

10.2

An important aim of the dialogue between government and donors will be to

introduce at the country level the sense and spirit of a development partnership which is advocated at the global and multilateral levels, but which has so far not been realized at the country level. To enable such a development, actions of both donors and of the government are expected to be made more transparent with significant improvements in the flow of information between and among concerned actors.

Institutional Framework

10.3 Exploiting the potential of institutional arrangements: Several institutional

arrangements currently exist, which have a relevance to enhancing the effectiveness of the foreign aid management in the country. These include (a) increasing the effectiveness of economic diplomacy through more fruitful and effective participation of competent HMG agencies in the process; (b) In order to effectively implement the foreign aid policy, planning divisions of the relevant ministries will be strengthened, particularly in areas of project preparation, evaluation, supervision and monitoring capacity; (c) The existing Foreign Aid Coordination Division would be upgraded to External Economic Relations Department in view of the need to address concerns like improving aid resource management, and raising the efficiency in the use of aid resources; and (d) The Social Welfare Council would be strengthened so that it could provide "one window "services to NGOs/INGOs, and serve as their focal point for all practical purposes.

10.4 Review Mechanism: The National Planning Commission will take lead role in the

review of the development projects and programs. The efficient implementation of projects can only be ensured through continuing systems of supervision, monitoring and evaluation and through undertaking impact studies. The problem so far has been that these have been undertaken only at random. The importance of these aspects of overall project management will be stressed. There will be strong feedback mechanisms, and opportunities provided for a wide spectrum of stakeholders to voice their views on these projects. Reporting systems will be streamlined and on the basis of these reports, there will be close interaction between policy makers and project implementers. A plan will be prepared to undertake regular evaluation studies of foreign funded project and programs.

XI. CONCLUSION

11.1 HMG is seriously committed to the new foreign aid policy to implement it with sincerity

and determination that it deserves, in the hope that the smooth implementation of the Policy will

pave the way for meeting the development objectives and targets for poverty reduction envisaged in the PRSP/Tenth Plan.

11.2 HMG recognizes that the new aid policy lays out an ambitious agenda. It believes that, to

address the long-standing concerns of both the donor community and the Nepalese stakeholders, such a comprehensive effort is required. This is clearly an undertaking which will take time, as well as commitment, understanding and will on the part of all development partners. If successful, the new approach can become the basis for a new and much more productive compact

among Nepal’s development partners and can make a critical difference to Nepal’s efforts to reduce poverty. The challenge for both Nepal and the donor community in the coming months after the Nepal Development Forum (NDF) meeting will be to sit down and work closely together to translate this policy into a concrete program of action for the immediate future.